Monday, August 11, 2014

Wall Street discovers income inequality

by digby

Josh Holland highlights a very interesting report from Standard and Poor's last week in which they discover that a small handful of rich people don't seem to be able to spend as much money as hundreds of millions of working folks. Imagine that:

For many years there were some economists who argued that their discipline shouldn’t worry about inequality. Economists, they said, should focus on efficiency and growth, and leave the distribution up to the political world. But a research brief released on Tuesday by the Wall Street ratings agency Standard and Poor’s concludes that growth versus equality is a false choice. The authors argue that while some inequality may be desirable in a market economy — it spurs entrepreneurship and innovation — when those at the top take too large a share of a nation’s output, they tend to bank it rather than spend it. This ultimately hurts consumer demand and slows down economic growth. They also note that “higher levels of income inequality increase political pressures, discouraging trade, investment, and hiring.”

The point of the brief that made headlines this week is this: “Our review of the data, as well as a wealth of research on this matter, leads us to conclude that the current level of income inequality in the US is dampening GDP growth, at a time when the world’s biggest economy is struggling to recover from the Great Recession.”

That seems like a "no-duh" to me. But they also discovered something else that I don't think has been quite as obvious, although it should be. They noted that people being too poor to live a middle class lifestyle will often borrow too much and otherwise be financially unstable --- which leaves the economy susceptible to more dramatic economic shocks.

“As income inequality increased before the crisis, less affluent households took on more and more debt to keep up–or, in this case, catch up–with the Joneses,” the analysts write. “Further, when home prices climbed, these households were willing to borrow against their newfound equity–and financial institutions were increasingly willing to help them do so, despite slow income growth. A number of economists have pointed to ways in which this trend may have harmed the US economy.”

People aren't just borrowing too much because they want to keep up with the Joneses. They just want to live a normal middle class life, raise their kids, send them to school, save a little for retirement but the 1% is hoovering up more and more of the wealth in this country at the same time that wages are stagnant for everyone else. Borrowing is a simple hope that somehow, some way the future will be a little bit better.

In case you were wondering, the report doesn't endorse raising taxes or any sort of terrible redistribution scheme. But it does note that somebody should do something. Baby steps.

Ever since the financial crisis, corporations have managed to deliver robust profit growth by offsetting the drag of weak sales growth with widening profit margins. These fatter profit margins come from cutting costs, which usually means getting more productivity out of a fewer number of workers.

Some market watchers have warned that there aren't any more costs to be cut. But during their Q2 earnings announcements and conference calls, corporate America confirmed otherwise.

"S&P 500 margins expanded to a new historical high of 9.1%," said Goldman Sachs' David Kostin. "Margins exited the 50 bp range between 8.4% and 8.9% for the first time in four years. Trailing four-quarter margins expanded by 17 bp versus 1Q 2014. The Information Technology and Health Care sectors were the largest contributors to index level margin expansion. Margins declined for only one sector, Energy, while Consumer Discretionary margins were unchanged."

And that's not all. Based on the analysts' forecasts of S&P 500 companies, those profit margins will average 9.3% for the year and then jump t0 10.0% in 2015.